Incoterms

What are Incoterms?

Freight incoterms (International Commercial Terms) are the standard contract terms used in sales contracts with importing/exporting to define responsibility and liability for shipment of the goods. In plain English – how far along the process will the supplier ensure that the goods are moved, and at what point does the buyer take over the shipment process.

The Incoterms? are a set of 11 individual rules issued by the International Chamber of Commerce (ICC) which define the responsibilities of sellers and buyers for the sale of goods in international transactions. Of primary importance is that each Incoterms rule clarifies the tasks, costs and risks to be borne by buyers and sellers in these transactions. Familiarizing yourself with Incoterms will help improve smoother transaction by clearly defining who is responsible for what and each step of the transaction.  

The Incoterms? 2020 rules are updated and grouped into two categories reflecting modes of transport. Of the 11 rules, there are seven for ANY mode(s) of transport and four for SEA or LAND or INLAND WATERWAY transport.  

Every 10 years, the ICC updates the Incoterms to ensure that they stay consistent with the current process of international trade. Incoterms were last updated on January 1st, 2020, and include 11 unique types. 

When buyers are purchasing products internationally, sellers will often include a three-letter abbreviation of one of the 11 Incoterms to define what the terms of the trade shall be. These terms represent various tasks, costs, risks, and logistics of getting goods whether by sea freight, air freight, and land freight. 

Every Incoterm defines the following responsibilities and obligations: 

• Point of delivery – This section outlines where the goods will be transferred from the seller to the buyer. 
• The responsible party for transportation costs – The section defines which party will cover the freight costs. This component is often characterized as Freight Prepaid or Freight Collect. 
• Export and import requirements – Each term defines whether the seller or buyer is responsible for covering the costs and facilitating the export and import of the cargo.   
• The responsible party of freight insurance – In some Incoterms, freight insurance is a requirement. Each Incoterm will define who must pay for freight insurance. 

The seven Incoterms? 2020 rules for any mode(s) of transport are: 

Any Mode of Transport

• EXW - Ex Works - Seller is only responsible for having the goods packed made available at the seller's premises. The buyer bears the full risk and costs from there to the destination - including the loading of the cargo.
• FCA - Free Carrier - Seller is only responsible for delivery to the named place. The seller is responsible for the loading. Risk and cost are transferred to the buyer as soon as delivered at named place. Unloading is the buyer's responsibility. 
• CPT - Carriage Paid To - Seller arranges the transportation and costs to the named destination. Risk is transferred to the buyer once delivered at the first carrier. 
• CIP - Carriage and Insurance Paid to - Seller arranges the transportation, costs, and insurance on behalf of the buyer to the named place at the destination. Risk is transferred to the buyer once delivered at the first carrier. The seller must obtain extensive insurance cover complying with insurance Cargo Clauses (A) or a similar clause in the buyer's name.
• DAP - Delivered at Place - Seller delivers the goods to the agreed place at the destination. Seller assumes all costs and risks until the goods are ready for unloading at the named place of destination. 
• DPU - Delivered at Place Unloaded - Seller assumes all costs and risks until the goods are unloaded at the agreed named place of destination. The buyer is responsible for import customs formalities.
• DDP - Delivery Duty Paid - Seller delivers goods to the agreed place destination. Seller assumes all costs - including import formalities and risks until the goods are ready for unloading at named place of destination.

The four Incoterms? 2020 rules for Sea and Inland Waterway Transport are: 

Sea and Inland Waterway Transport

• FAS - Free Alongside Ship - Seller is responsible for delivering goods at the port alongside the vessel. From this point, onwards risk and cost transfer to the buyer. 
• FOB - Free On Board - Seller is responsible for goods loaded onboard the vessel. Risk and cost are transferred as soon as the goods have been loaded on board the vessel. 
• CFR - Cost and Freight - Seller covers freight costs to the named port of destination or place. Risk is transferred as soon as the goods have been loaded on board the vessel.
• CIF - Cost, Insurance, and Freight - Seller covers insurance and freight costs to the named port of destination or place. Risk is transferred as soon as the goods have been loaded on board the vessel. Seller is required to obtain the minimum insurance cover complying with Institute Cargo Clauses (C) in the buyer's name.

 The most commonly used Incoterms are EXW – Ex-Works FOB (Free On Board), EXW (Ex Works),  FCA (Free Carrier), DAP – Delivered At Place · DDP – Delivered Duty Paid.

Let’s look at the Incoterms in more detail:

EXW Incoterm (Ex Works)

EXW puts the most responsibility on the buyer. The buyer will have to pick up the cargo from the seller’s premises and handle everything from that point on, including arranging for pre-carriage, export Customs clearance, arranging for main carriage, etc. Some traders like EXW because they believe it allows them to recognize revenue at the earliest possible instance. However, Incoterms do not define revenue recognition rules. This is the best Incoterm to use if the buyer wants to handle everything for a shipment without seller’s interference or support.

• Export clearance: Buyer
• Freight costs: Buyer
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: At seller’s facility or named place

FCA Incoterm (Free Carrier)

FCA requires the seller to do a little more work than EXW. Delivery can be at the seller’s warehouse or another chosen point. If the point of delivery is at the seller’s warehouse, the seller will have to load the cargo onto the buyer’s collecting vehicle. However, the buyer will still have to make most of the other arrangements like main carriage and import Customs clearance. The seller will be the exporter of record at the origin. Hence, this is a good Incoterm to use when the buyer wants to arrange the main carriage and requires the seller to be the exporter of record. Under the 2020 version of the terms, FCA specifies that if required, the buyer must request the carrier to issue an on-board B/L to the seller.

• Export clearance: Seller
• Freight costs: Buyer
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: Seller’s facility or named place

CPT Incoterm (Carriage Paid To)

CPT requires the buyer to pay for carriage to the first carrier or agreed delivery point. Seller will clear Customs at origin as the exporter. This rule is suitable if the seller has access to cheaper transportation rates. The point of delivery must be specifically tied down in the sales contracts. This rule is a favorite among traders since it generally allows earlier revenue recognition since delivery is made early. However, it must be mentioned (again) that Incoterms DO NOT specifically define revenue recognition principles.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: Handing over the carrier

CIP Incoterm (Carriage and Insurance Paid To)

This rule is similar to CPT, but in this case the seller must also purchase insurance. This rule is suitable if mandating sufficient insurance of the cargo is a concern. Many traders use CIF instead of CIP. However, CIF is a maritime transport only term while CIP can be used for any mode of transportation. The level of insurance cover under CIP is more comprehensive than CIF. Like CPT, many businesses like CIP since it supports an argument for early revenue recognition.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Seller for buyer’s benefit
• Mode of transport: Any mode
• Delivery point: Handing over to the carrier

DAP Incoterm (Delivered at Place)

This rule requires the seller to arrange for pre-carriage, main carriage and sometimes on-carriage. The seller, however, will not be the importer of record in the destination. The seller is not responsible for unloading the cargo at the named place. This term is suitable if the seller has access to better transportation rates than the buyer.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: Named place

DPU Incoterm (Delivered at Place Unloaded)

This term is similar to DAP. However, when DPU is used, the seller must also ensure that the cargo is properly unloaded as the place of delivery. This rule is suitable when the cargo is of a nature that requires special handling for unloading that the seller is better equipped to manage.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: Named place

DDP Incoterm (Delivered Duty Paid)

DDP is effectively a door-step delivery arrangement and the only Incoterm that requires the seller to be the importer of record in the destination. However, it does not require the seller to unload the goods at the destination. This term is suitable when the seller prefers to handle everything up to the door of the buyer and when the buyer has the necessary equipment to unload the cargo at his/her facility.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Seller
• Insurance: Nil
• Mode of transport: Any mode
• Delivery point: Named place

FAS Incoterm (Free Alongside Ship)

In FAS, delivery is made when the cargo is placed on the wharf alongside the vessel. Use of this term is uncommon, although it may still be relevant when the cargo consists of large and heavy machines or automobiles. The seller must carry out export clearance procedures while the buyer is responsible for import clearance activities.

• Export clearance: Seller
• Freight costs: Buyer
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport: Ocean or waterway
• Delivery point: Alongside vessel

FOB Incoterm (Free On Board)

FOB considers delivery to be made when cargo is loaded onto the vessel. However, since the condition of containerized cargo cannot be ascertained at the time of vessel loading this Incoterm should not be used for containerized cargo. Buyers should use FOB when they want to arrange for their own main carriage and on-carriage.

• Export clearance: Seller
• Freight costs: Buyer
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport:Ocean or waterway
• Delivery point: On board vessel

CFR Incoterm (Cost and Freight)

Similar to FOB terms, CFR considers delivery to be made when cargo is loaded onto the vessel. On that note, this term should not be used for cargo that is shipped in containers. This term may be suitable for bulk non-containerized cargo that the seller wants to arrange main freight for.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Nil
• Mode of transport:Ocean or waterway
• Delivery point: On board vessel

CIF Incoterm (Cost Insurance and Freight)

Similar to CFR, CIF considers delivery to be made when cargo is loaded onto the vessel which makes this term also unsuitable for containerized shipments. Traders may find this term suitable when they are dealing with non-containerized bulk commodities. In this term the seller has to arrange for freight.

• Export clearance: Seller
• Freight costs: Seller
• Import clearance: Buyer
• Insurance: Seller for buyer’s benefit
• Mode of transport: Ocean or waterway
• Delivery point: Onboard vessel

Incoterms Clarify Responsibilities of Parties to a Sales Transaction

• For example, in each Incoterm rule, a statement is provided as to the seller’s responsibility to provide the goods and commercial invoice in conformity with the contract of sale. Likewise, a corresponding statement is provided which stipulates that the buyer pay the price of goods as provided in the contract of sale. 
• Each Incoterm rule has a statement stipulating which party is responsible for obtaining any export license or other official authorization required for export and for carrying out the customs formalities necessary for the export to proceed. Similarly, each rule has a corresponding statement as to which party is responsible for obtaining any import license or other official authorization required for import and for carrying out the customs formalities required for the import of goods. These statements also specify which party bears the cost of handling these tasks. 
• Similarly, each Incoterm rule specifies which party to the transaction, if any, is obligated to contract for the carriage of the goods. Another point addressed in each Incoterm rule is which party, if any, is obligated, to provide for cargo insurance coverage. These statements also specify which party bears the cost of handling these tasks. Each rule also contains statements, among others, as to which party is responsible for packing the goods for transport overseas and for bearing the costs of any pre-shipment inspections.  
• A final example is cargo delivery. Each Incoterm rule specifies the seller’s obligations as for cargo delivery and clarifies when delivery takes place. Each rule also specifies when the risk of loss or damage to the goods being exported passes from the seller to the buyer by reference to the delivery provision.  

What Incoterms Do Not Cover  

As noted above, Incoterms are generally incorporated in the contract of sale, however, they do not: 

• address all the conditions of a sale;  
• identify the goods being sold nor list the contract price;  
• reference the method nor timing of payment negotiated between the seller or buyer;   
• when the title, or ownership of the goods, passes from the seller to the buyer;  
• specify which documents must be provided by the seller to the buyer to facilitate the customs clearance process at the buyer’s country; and  
• address liability for the failure to provide the goods in conformity with the contract of sale, delayed delivery, nor dispute resolution mechanisms.  

Why are Incoterms Important?

Buyers should consider incoterms before the contract of sale is negotiated, or risk being stung by the supplier on the deal, and/or having unnecessary complications to the shipment.

Advantages of Using Incoterms

Incoterms communicate a binding agreement between the buyer and seller that outlines the responsibilities between the manufacturer and purchaser of goods in regards to the delivery to the products. 

While it is not a requirement for sellers to quote an Incoterm when selling internationally, the advantage of doing so helps avoid confusion over roles and responsibilities between the two parties. As language barriers and cultural differences are commonplace in international trade, these terms simplify an often complicated process and help communicate a large portion of the process of transferring the goods from the seller to the buyer. If you’re new to importing and incoterms, consider working with a China freight forwarder to avoid costly misunderstandings.

What is the difference between ‘Freight Collect’ and ‘Freight Prepaid’? 

Freight Prepaid and Freight Collect are terms that can commonly be used between buyers and sellers when discussing international freight. When a seller mentions ‘Freight Collect’, they refer to one of the four Incoterms that require the buyer to collect and pay all freight charges. The Incoterms associated with Freight Collect are: 

1. EXW – Ex Works or Ex-Warehouse
2. FCA – Free Carrier
3. FAS – Free Alongside Ship
4. FOB – Free on Board 

Freight Prepaid indicates the seller will pay for the freight charges. The remaining seven Incoterms consist of Freight Prepaid:

1. CFR – Cost and Freight
2. CIF – Cost, Insurance & Freight 
3. CPT – Carriage Paid To 
4. CIP – Carriage and Insurance Paid To 
5. DAP – Delivered At Place 
6. DPU – Delivered At Place Unloaded
7. DDP – Delivered Duty Paid

What types of insurance is a seller required to obtain when shipping under CIF and CIP Incoterms? 

Two International Commercial Trade Terms require the seller to purchase insurance on the cargo prior to shipment. These two terms are CIF and CIP. Each of these terms has unique requirements for the type of insurance a seller must obtain. 

• CIF, or Cost, Insurance & Freight requires an insurance policy with the minimum cover of the Institute Cargo Clause (C).
• CIP, or Carriage & Insurance Paid To requires an insurance policy with a minimum cover of the Institute Cargo Clause (A). 

8 facts about Incoterms you should know.....

1. It all started way back over 200 years ago: In 1812, British Courts established Free On Board (FOB) shipment terms indicating who is liable for damaged in shipping were established. These established rules were the seeds that would eventually grow into Incoterms? we know today!
2. Booming Trade: Up until 1936, the original FOB rules were updated only once. It was in this year that the ICC would publish 6 rules, making these the first truly global standardization for worldwide trade.
3. World War II: After the second world war, lots of trade standards and agreements had to be mended, re-written, and new rules established.
4. New Modes = New Rules: As new forms of transportation emerged, Incoterms had to evolve as well. In 1953, 3 new rules were added to include Trains, Trucks, and specific costs.
5. FOB: The first air freight was officially delivered in 1910, but it took until 1976 to include air FOB rules into Incoterms?!
6. Electronification: in 1990, Incoterms? underwent a massive re-build, as more and more electronic services became available.
7. Ever-changing landscape: In 2010 with so many changes and increases with shipping, Incoterms? had to make adjustments as well. In 2010, 4 Incoterms were done away with, and 3 all-new Incoterms were added.
8. Incoterms? 2020 were released!

How do a buyer and seller agree on which Incoterm to use? 

Unless specifically requested by a buyer, sellers often have preferred Incoterms they use that work best for them and their customers. Buyers can often have unique preferences, which are conveyed to sellers, and through this communication, a buyer and seller can come to an agreement on the most ideal Incoterm for their deal. 

In order for Incoterms to be contractually valid, the terms should be listed on the purchase agreement, sales invoice, or sales contract. As these are contractual terms, buyers and sellers should be clear with their agreement and not rely on verbal communication to define the responsibility of each party when shipping products internationally. 

There is no special documentation or form needed when selecting an Incoterm; instead, the term should be listed in conjunction with the product price and defined as the agreed-upon incoterm. 

Incoterms can change during an order process. For example, if a shipment was intended for sea, but due to delays or unforeseen circumstances, the shipment needs to be shipped via air, an Incoterm could change. As we discussed above, not all terms are valid for air travel. If there is a change in the terms, buyers and sellers would need to communicate this change, just as they would communicate any other change taking place in a purchase agreement.  

Thanks..

N.kumar